As the situation in Greece unfolds, it's easy to believe that the country will soon be forced into default much like an illiquid and/or insolvent company would be under similar circumstances. The Greek leadership will simply get up one day to discover that its checks from the day before have bounced. It will then have no choice but to march down to the local courthouse with bankruptcy petition in hand.
Yet the reality is that countries don't go broke in the same sense that a firm or a company might. They don't go out of business, in other words, as they can generally repay foreign creditors given enough pain and suffering on the domestic front. The decision turns instead on a country's willingness to pay and not its ability to do so. Lest you have any doubts, according to data compiled by Carmen Reinhart and Kenneth Rogoff for the study "This Time is Different," more than half of defaults by middle-income countries between 1970 and 2008 occurred when the afflicted country's debt service payments were handily sustainable.
So why do countries choose to default when they could otherwise pay off their debts? The answer is simple: It's easier. To illustrate why, I've chosen to take a look at Romania's experience in the 1980s, as it's the only modern country to fully satisfy an otherwise onerous foreign debt burden without resorting to actual default, constructive default via inflation, or some type of debt restructuring. And as you'll see, the decision to do so turned out to be a fateful one for Romania's leader and his wife.
A leader's silent war on his people
Romania borrowed heavily throughout the 1970s to finance the modernization of its energy sector. Its goal was to become one of Europe's principal suppliers of secondary petroleum products. Unfortunately, the decision to pursue this course couldn't have come at a worse time, as the new capacity came on line just in time to see the price of oil triple after the Iranian revolution. Because the price of secondary oil products failed to rise proportionately, moreover, Romania proceeded to lose $25 on every ton of refined products it sold to the West. And by 1980, the country was posting a record $1.5 billion trade deficit -- a non-negligible amount for a country of Romania's size.
To avoid defaulting on its now-quaint $11 billion foreign debt, the country's Soviet-style leader Nicolae Ceausescu chose the path of austerity in 1982, initiating what came to be known as his "silent war" against the people. His plan was to pay off Romania's debts in eight years by turning its aforementioned trade deficit into a trade surplus. Doing this, however, required two things. In the first case, the country had to minimize imports by reducing internal demand for them. And in the second case, it had to maximize exports of domestically produced goods such as energy and agricultural products. Ceausescu accomplished both (see the figure below) by rationing basic amenities such as heating fuel in the winter and basic foodstuffs throughout the year.
Source: International Monetary Fund's 2011 World Economic Outlook Database.
Although these measures were ultimately successful -- Romania's foreign debts were paid off by 1989 -- the resulting carnage left many wondering whether it was worth it. In addition to a purported 15,000 deaths a year from freezing and malnutrition due to the rationing, Romania's economy collapsed into an economic malaise worse than that of the Great Depression. From peak to trough, its GDP began a staggering 67% descent in the latter years of Ceausescu's regime. And it didn't regain its 1988 high until 16 years later in 2004 -- a mere five years before it collapsed again in the midst of the Great Recession. Not to put too fine a point on it, but both Ceausescu and his wife were ultimately tried and executed for these transgressions.
The lessons of Romania's austerity
In light of Romania's experience, it should be no surprise that the governments of heavily indebted European countries are buckling under the pressure of the continent's debt crisis. Italy's fell last November when its elected prime minister was replaced by a nonelected technocrat known as Il Professore ("The Professor"). Greece's fell the same month when a similarly nonelected technocratic banker assumed the reins. And Romania's fell again earlier this month after its prime minister submitted his resignation, citing the need to "defuse political and social tension" over a new round of austerity cuts.
The lesson is that extreme austerity measures are simply not sustainable without an unelected autocratic leader who's willing and able to subjugate the will of his people in favor of creditors abroad. And it's for this reason that I fervently believe most if not all of Europe's heavily indebted countries will eventually default in one form or another. Indeed, despite their assertions to the contrary, it's no longer a question of if, but rather when.
Foolish bottom line
With this in mind, I'd advise investors to steer clear of European stocks for the time being. According to my colleague Alex Planes, betting on companies like the National Bank of Greece
A much better alternative would be a company like Procter & Gamble
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